Hazelton Capital Partners letter to investors for the first quarter ended March 31, 2018 featuring a big position in USA Technologies, Inc. (NASDAQ:USAT) a PCI compliance company.
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To: Hazelton Capital Partners, LLC
From: Barry Pasikov, Managing Member
Date: April 24, 2018
Re: 1st Quarter 2018 Letter to Investors
Hazelton Capital Partners, LLC (the “Fund”) gained 1.8% from January 1, 2018 through March 31, 2018 and has returned 132% since its inception in August 2009. By comparison, the S&P 500 lost 0.8% in the same quarter and has returned 203% since the Fund’s inception.
The Quarter in Review – Position Updates
Hazelton Capital Partners ended the 1st quarter with a portfolio of 17 equity positions and a cash level equivalent to 18% of assets under management. The top five portfolio holdings, which are equal to roughly 43% of the Fund’s net assets, are: Micron Technology (MU), Western Digital (WDC), USA Technologies (USAT), Apple Inc (AAPL) and Manitowoc Company (MTW). For those keeping score, Manitowoc Company is a new addition to the top five holdings but is not a new addition to the portfolio. In fact, MTW had grown into a top five holding in the 4th quarter of 2017 but the Fund took profit on 1/3 of the position. In early March of 2018, Hazelton Capital Partners was given the opportunity to buy back nearly all the shares it had sold at a 30% discount to our selling price.
Manitowoc Company (MTW) Current Holding
Manitowoc Company is a leading global designer, manufacturer, and distributer of cranes for the construction industry. In March of 2016, Manitowoc spun-off its food service business (Manitowoc Foodservice/Welbilt – WBT) which represented approximately 75% of the company’s total market capitalization and contributing most of the profits. The reason for the spin-off was to “unlock” the value of the foodservice business that was being hidden by the low margined crane segment. Manitowoc’s crane business suffered from years of underinvestment and operational inefficiencies, while operating in a highly competitive, very cyclical (boom or bust) global industry, an industry that is still recovering from the impact of the financial crisis. Barry Pennypacker was brought in as CEO to realign the crane segment, bringing with him over 20 years of manufacturing experience while serving as CEO of Gardner Denver, and other high-level executive positions at Wabtech, Westinghouse, Stanley Works and Danaher Corp. Pennypacker’s goal is to expand MTW’s margins by streamlining operations, reduce product defects, increase manufacturing agility and productivity, and reduce material costs and inventories, which leads to higher margins and lower working capital needs.
Manitowoc has made steady progress since Pennypacker took the helm, but realigning manufacturing requires capital, time, and initially comes at the cost of lower output. The company has yet to see the total impact of its efforts fully reflected in its financials. Additionally, the recent posturing by the US on steel imports and the proposed tariff retribution by the Chinese is creating a headwind for both the company and its stock price. Hazelton Capital Partners still believes there to be continued upside to the value of the company and took advantage of the recent sell-off in the stock price to rebuild the MTW into a top five holding.
Keep Your Sights on the Horizon
Just after college, a few friends and I took a 30-foot sailboat out for a cruise on Lake Michigan. It happened to be a very windy day, and 30 minutes after we left the harbor, I began to feel the impact of the swells. My friend, who was captaining the boat, saw the uneasy look on my face and suggested that I focus on the horizon. It was sound advice. Staring at a fixed point of reference in the far-off distance did not make the waves any smaller or the boat more stable, but it did give my mind a steady point of reference and change my perception of the boat’s movement. Since early February, many investors have been feeling that same uneasiness as they fixate on the daily ebbs and flows of the market, thanks in large part to our “Twitter-in-Chief.”
Volatility is an inevitable by-product of investing in financial markets. There is only one way to eliminate volatility from an investors’ portfolio - keep all assets in cash. While investors may disagree as to how or what to invest in during times of market instability, I think all would agree that the greater the uncertainty, the greater the market volatility - (or perhaps it’s the greater the market volatility, the greater the uncertainty). But are volatile markets riskier?
Most investors have been conditioned to invest during times of market strength, and for the past eight plus years that is exactly what the markets have delivered. Manipulated by the Federal Reserve, the historically low interest rates have been engineered to underpin the equity markets by luring investors back into the market. Investors are now waking to the fact that interest rates (even though at historically low levels), oil prices, and market volatility are on the rise. Fearing that the bull market may have finally run its course, many are beginning to take shelter in cash. It is commonplace for investing strategies to increase their cash holdings during times when market fundamentals or corporate profits become unhinged. What makes the recent volatility “unusual” is that the market movement has not been driven by declining economic growth or deteriorating corporate earnings, as both have shown steady and predictable progress. What appears to be driving the recent volatility is the fear of not selling the top of the market, leading to the reaction (mostly overreaction) to the random and often contradictory tweets from our “very stable genius,” President.
Assets come in three flavors: undervalued, fairly valued, and overvalued. Not every “expensive” stock is overvalued or “cheap” stock undervalued, and at some point along its timeline, shares of a stock will achieve all three flavors. A stock’s valuation is based primarily on its operating metrics, its industry and prospects, and its runway for growth. Selling a stock based purely on market sentiment is the proverbial: “Throwing the baby out with the bathwater.”
Hazelton Capital Partners does not try to time the market; instead, the Fund has been harnessing the recent market volatility. Although options are strategically used to hedge a position or segment within the portfolio, the Fund’s first line of defense has always been the caliber of the assets we purchase and at what price we either buy or add-to those positions. Keeping our eye on the “investing horizon,” the Fund was unusually active during the first quarter by opportunistically deploying capital into three existing positions.
USA Technologies (USAT) Current Holding
Shares of USA Technologies were paired down in the 4th quarter of 2017. And like Manitowoc, Hazelton Capital Partners was able to re-establish the position at a meaningful discount in which the shares were sold in December of 2017. USA Technologies has been discussed several times in past quarterly reports, and the overall thesis for the company and outlook for the industry has not changed. In fact, based on continued research, Hazelton Capital Partners believes that the unattended retail segment has recognized the strength of cashless vending, as industry leaders are transitioning 100% of their machines to accept cashless transactions. Even though cashless vending has gained momentum with approximately 20% of vending machines accepting cashless transactions, there is still a meaningful runway for growth.
USA Technologies’ recent acquisition of Cantaloupe Systems has created an end-to-end enterprise platform while expanding USAT’s footprint outside the US into Canada, Australia, and South America. Combining USA Technologies’ transaction and back office software with Canteloupe’s vending management systems (VMS) has created a key player in the unattended retail industry. Soon after the acquisition was completed, French based Ingenico Group, a global leader in seamless payment solutions, announced a three-year strategic alliance with USAT. The goal of the alliance is to capture the expanding unattended retail and micro markets by combining Ingenico’s hardware and security platform with USAT’s transaction and VMS services. Although not openly discussed, the combination of Canteloupe’s VMS with USAT’s vending machine connections, transaction, and back office software has turned USA Technologies into a much more meaningful acquisition target. Some believe that Ingenico’s strategic alliance could be the prelude to an acquisition down the road.
Hazelton Capital Partners is mindful that the unattended retail industry is poised to consolidate with a key player, like USA Technologies, being highly coveted. This has not influenced the level at which the Fund has bought and sold shares, which it has done several times since investing in USAT. However, Hazelton Capital Partners has been able to integrate USAT’s preferred shares into our overall USAT investment, as a synthetic “call option” and long-term placeholder.
USA Technologies issued its convertible preferred shares (USATP) several years ago at $10/share. Every year, the preferred shares accrues approximately $1.50 worth of dividends that has yet to be paid out to shareholders, giving the preferred shares an implied valuation of $42.93/share (as of the end of March 2017) vs. USATP which trades at $23.15/share (as of the end of March 2017). USAT’s board is only obligated to pay out the accrued dividend and redeem the preferred shares upon a merger/acquisition of the company. Hazelton Capital Partners initially began acquiring shares of USATP below $19/share and then added to the position each time the Fund sold some of its shares of USAT common. The plan was to replace the “fair valued” common shares with undervalued preferred shares. If USAT were to be purchased after the Fund had reduced its common shares, then Hazelton would benefit from the preferred shares. There were also times when Hazelton Capital Partners was able to reverse the investment and sell USATP shares as the Fund repurchased USAT’s common shares. Hazelton Capital Partners does not expect: the preferred shares to close the gap between the implied valuation and its current price, the board to pay out the accrued dividends, or the company to be bought anytime soon. The Fund’s investing thesis is reflective of the accelerating growth in the industry and USAT’s ability to play a key role in that growth.
Tesco (TSCO:LN) – Closed 15% Gain
Hazelton Capital Partners invested in Tesco Plc in Q4 of 2014. At the time, Tesco was the third largest global retailer behind Wal Mart and Carrefour. With retail operations in 12 countries across Europe and Asia, Tesco’s largest footprint was in the United Kingdom with a 30% market share in the UK grocery market. Starting in early 2014, Tesco began to run into some significant operational challenges in which most, if not all, were of its own design. The company’s sheer size and recent focus on international growth (outside the UK) caused its management to become distracted and slow to react to changes in consumer spending habits. Discount retailers, like Aldi and Lidl, took advantage of Tesco’s slow response and began eroding its market share.
Believing that TSCO’s new CEO, David Lewis, would be successful at cutting expenses, reducing the company’s store count and footprint, dealing with accounting irregularities, and decreasing the debt on the balance sheet, Hazelton Capital Partners began investing in the retailer. The Fund was not expecting a quick turnaround but believed that over time management would be able to leverage its brand, assets, and infrastructure, while expanding its logistics system to stem the eroding tide. With the margins at the time less than half of what they used to be a few years earlier, even a small positive momentum would go a long way to improving Tesco’s value and its share price. However, as Tesco’s outlook began improving, foot traffic and door closures at malls and large box retailers began to negatively impact the global industry, especially in countries where ecommerce had a strong foothold. The entire retail segment began to trade at a discount, and even though Tesco’s management held up its end of the bargain with positive quarter over quarter improvement, the price of the stock failed to reflect the full earnings power of the company.
With increased competition from discount retailers like Aldi and Lidl, changes in consumer shopping habits, declining foot traffic, and the recent entry of Amazon into the industry with its acquisition of Whole Foods, the valuation for Tesco has fallen. Even though Hazelton Capital Partners still believes there to be upside to Tesco’s valuation, the Fund decided to exit the position and search out a company with a longer runway of growth.
Investing in Hazelton Capital Partners
Hazelton Capital Partners was created as an investment vehicle, allowing those interested in long-term exposure to the equity market to invest along-side me. With a substantial portion of my own capital in the fund, I manage Hazelton Capital Partners assets in the same manner in which I manage my own capital. The best source of introduction to potential investors in the Fund has come from those that have invested or followed Hazelton Capital Partners progress over the years. Introductions are both welcome and appreciated.
If you are interested in making or increasing your contribution to Hazelton Capital Partners or just learning more about The Fund, please feel free to contact me.
Please do not hesitate to call me at (312) 970-9202 or email me [email protected] with any questions or concerns.